No More Disappearing Revenue in Business Combinations

Under current accounting standards, businesses acquired with deferred revenues as of the transaction date have frequently experienced haircuts to the related revenues reported in the post-acquisition financial statements.  Changes were recently made by the FASB to remove such negative results.  With early adoption provisions, the issue of disappearing revenues may be avoidable as early as in 2021.

What’s New?

The FASB recently issued Accounting Standards Update (ASU) 2021-08, Business Combinations (Topic 805) Accounting for Contract Assets and Contract Liabilities form Contracts with Customers.  The ASU requires companies to apply the new revenue recognition standard, ASC 606, Revenue from Contracts with Customers, to recognize and measure contract assets and liabilities from contracts with customers acquired in a business combination.  The new requirement creates an exception to the general recognition and measurement principle in ASC 805, Business Combinations, which requires substantially all acquired assets and liabilities to be measure at fair value as part of purchase accounting. 

What’s the Impact?

Prior to the new ASU, deferred revenue that was acquired as part of a business combination was measured at fair value.  The fair value measurement commonly resulted in a reduction or “haircut” to the amount of deferred revenue that was previously recognized in the acquiree’s financial statements prior to the acquisition.  The haircut resulted in a reduction of future revenue in the acquirer’s post-acquisition financial statements as compared to the amount of revenue that would have been recognized by the acquiree if the acquisition had not occurred.

We expect the new ASU to result in more revenue being recognized by the acquirer in its post-acquisition financial statements related to acquired deferred revenue.  The amount of revenue recognized should be consistent with the amount the acquiree would have recognized under ASC 606 if the acquisition had not occurred. 

Scope

The new ASU is applicable to all companies (public and private) and applies to all acquired assets and liabilities that meet the definition of contract assets and liabilities under ASC 606.  The ASU does not impact the accounting for customer or contract-related intangible assets recognized in a business combination.  It also does not apply to other assets or liabilities recognized under ASC 606, such as the accounting for incremental costs incurred by an acquiree to obtain a contract with a customer under ASC 340-40, Other Assets and Deferred Costs – Contracts with Customers.  Such incremental costs, which ASC 340-40 may have required to be recognized as a deferred cost asset, will still be subject to the fair value remeasurement as part of purchase accounting whereby fair value is usually significantly less than the amount previously recognized by the acquiree.   

Initial Accounting and Practical Expedients

As part of purchase accounting, the acquirer shall measure the acquired contract assets and contract liabilities as if the acquirer had originated the acquired contract.  An acquirer may use one or more of the following practical expedients seen below when measuring the acquired contract assets and liabilities.  These practical expedients may be useful when the acquirer is not able to assess or rely on the acquiree’s historical ASC 606 accounting or does not have the historical data to analyze the accounting.